Monday, May 14, 2012

The Global Debt Crisis, VI: What is "Money"?

Last week, in the previous posting of this series, we said we'd look at money in the next posting. Since this is the next posting, and we want our promises (our money) to be good, here it is. This involves the first two false assumptions that have gotten the world into the debt crisis. As they are closely related, we'll look at the first two assumptions under a single heading. "Money" is not restricted to coin, banknotes and demand deposits, with some time deposits thrown in for good measure. That is currency — "current money" — and currency substitutes. On the contrary, money is anything that can be accepted in settlement of a debt.

Money is not a claim issued by the State against the general wealth of society. That would make the State the ultimate owner of everything — socialism. Taxation is not an exercise of property, nor is eminent domain, any more than a conscripted soldier is a slave of the State.

Money and credit — two forms of the same thing — can best be understood in terms of Say's Law of Markets as applied in the real bills doctrine. In light of the current global debt crisis, it is hardly surprising that all the mainstream schools of economics and most of the minor ones reject Say's Law or redefine it into meaninglessness, and all of them reject the real bills doctrine.

Say's Law states that we can only purchase what others produce to the limit of what we produce. If we have produced nothing that we can exchange for what somebody else has produced, then no exchange will take place. Thus, if some people produce marketable goods and services that they can neither consume themselves nor trade to others, the correct action to take is not to reduce consumption, but to increase production.

As Say put it, "As no one can purchase the produce of another except with his own produce, as the amount for which we can buy is equal to that which we can produce, the more we can produce the more we can purchase. From whence proceeds this other conclusion, which you refuse to admit — That if certain commodities do not sell, it is because others are not produced, and that it is the raising produce alone which opens a market for the sale of produce." (Letters to Malthus, 1821, 2.)

"Money" is simply the medium of exchange by means of which we trade what we produce for what others produce. It is a symbol of the present value of what we own. As Louis Kelso explained,

"Money is not a part of the visible sector of the economy. People do not consume money. Money is not a physical factor of production, but rather a yardstick for measuring economic input, economic outtake and the relative values of the real goods and services of the economic world. Money provides a method of measuring obligations, rights, powers and privileges. It provides a means whereby certain individuals can accumulate claims against others, or against the economy as a whole, or against many economies. It is a system of symbols that many economists substitute for the visible sector and its productive enterprises, goods and services, thereby losing sight of the fact that a monetary system is a part only of the invisible sector of the economy, and that its adequacy can only be measured by its effect upon the visible sector." (Louis O. Kelso and Patricia Hetter, Two-Factor Theory: The Economics of Reality. New York: Random House, 1967, 54-55.)

The real bills doctrine is an application of this understanding of money. Currency — banknotes and demand deposits, as well as token coinage and anything else that circulates as "current money" in an economy and is accepted in settlement of a debt ("money") — is backed by the present value of whatever is represented by the negotiable instrument for which the "money" is exchanged.

All money, however, is a contract — a promise — and, in a sense, all contracts are money. Obviously, a contract can be made that delivers the present value of existing wealth. We would not otherwise have gold and silver coin — money that delivers something of value on the spot instead of the bearer having to take the money to the issuer and demand whatever the issuer of the money promised to deliver.

You can also enter into a contract to deliver something at a future date that you do not currently possess. If, however, you have a reasonable expectation that you will possess whatever is promised when the contract falls due, and the other party to the contract believes you (that is, accepts your offer), you have created money between the two of you based on the present value of something to be delivered in the future — and that might not even exist at the time you entered into the contract.

The money is cancelled when the contract is fulfilled, that is, the maker of the contract delivers goods or services as stipulated in the contract. It is thus possible to expand and contract the money supply as needed in an economy by tying the creation and cancellation of money through private property directly to the marketable goods and services being exchanged.

Negotiable instruments fall into three broad categories. These are bills of exchange, mortgages, and bills of credit. Bills of exchange are backed by the present value of future marketable goods and services. Mortgages are backed by the present value of existing marketable goods and services.

Bills of credit, however, are backed by the ability of the government to collect taxes out of wealth that exists now, in the future, or (depending on the optimism of the politicians and their effectiveness at selling pigs in pokes to the voters) might never exist. Greece's immediate problem, for example, is due largely to emitting bills of credit to be redeemed by taxing wealth that, increasingly, people are becoming convinced will never be produced.

Like Say's Law, the real bills doctrine can be stated fairly simply. If all new money is backed by a private property stake in the present value of existing and future marketable goods and services — that is, by contracts representing a private property stake in something with real value — there will always be enough money in the economy, and there will be neither inflation nor deflation.

There are a large number of refinements that can go into a discussion of Say's Law and the real bills doctrine, but that's not our concern at this time. All we're interested in is the basic theory. Our next posting in this series will address the issue as to whether by creating money government is simply shifting existing debt around, and whether public debt is "real" debt, or something that can safely be ignored as a debt we owe to ourselves and that doesn't have to be repaid.